Two Good Links from Megan

1. A panel at The University of Chicago, featuring John Huizinga (my former classmate at MIT), Kevin Murphy, and Robert Lucas.

Huizinga makes three points. First, we are hearing a lot of Keynesian macro being tossed around now, and it's not clear why. Second, so far this is not such a calamitous recession. The number of jobs lost is high, but relative to the size of the economy it's not out of line. (I would say that the media hype is greater for this recession. It's like the way that media magnify the horrors of war.) Some people forecast a long, deep recession, but it's a bit weird to base policy on a forecast of a long stagnation, when such forecasts are highly uncertain. The third point is that a fiscal deficit has costs as well as benefits. It will cut into national saving, which is not really a good thing long term.

Kevin Murphy points out that for fiscal stimulus to be cost-effective, the government has to make better use of resources. This is plausible when government uses unemployed resources, but it is implausible when government takes resources out of productive uses in the private sector. But if there is a 7 percent unemployment rate, then 93 percent of resources *are* being used, so the chances seem pretty high that a lot of the government spending is going to draw on resources that already are employed.

It's easy enough to argue that any single bank yields a superior result when that bank is nationalized rather than bailed out, for reasons ably discussed for Matt. The problem comes with the banks that sit on the margin, namely the banks that do not yet need either nationalization or a major bailout.

I agree that adding political risk is not exactly a way to attract capital to the banking sector. But I would go further and argue also against bailouts and re-capitalization.

Where I differ with Tyler, and with most nearly everyone else, is that I am not anxious to recapitalize banks and get lending started again. I think we need to transition away from a highly leveraged financial sector and instead have an economy where the nonfinancial sector finances expansion out of profits and by raising funds in straightforward ways from investors, without clever financial intermediation. The de-leveraging of the financial sector needs to be overseen in such a way that people do not lose access to basic banking services. But don't think in terms of re-invigorating the massive financial intermediation that existed a few years ago.

You say "The third point is that a fiscal deficit has costs as well as benefits. It will cut into national saving, which is not really a good thing long term."

I agree that a fiscal deficit has costs as well as benefits, but cutting into national savings (and by that I presume you mean private savings) is *not* one of them. In fact, it's just the opposite! A (Federal) fiscal deficit is exactly where the private sector gets the money to save! A larger fiscal deficit does not cut into private savings, it enables higher private savings.

"I think we need to transition away from a highly leveraged financial sector and instead have an economy where the nonfinancial sector finances expansion out of profits and by raising funds in straightforward ways from investors, without clever financial intermediation."

That seems to run completely counter to orthodox macroeconomic theory, winterspeak. When the government runs a deficit, it crowds out private investment; if the government takes a dollar in taxes and saves it, that's an extra dollar in national savings. If the government takes a dollar in taxes and gives it to someone else, that person will almost certainly not save the whole dollar. He'll save a certain amount and spend the rest based on his marginal propensity to consume. Indeed, it almost seems to me that the whole point of the stimulus (based on the arguments put forth in favor of it) is that we don't want people to save - we want people to be spending money.

So you expect a stimulus in excess of 7% per year? And that is current unemployment. Get serious. The real problem is getting it to create much of any jobs. Your argument is now not that it won't work but will work too well?

Question: Mankiw posts Barro critique of stimulus, comparing WWII multiplier to current conditions. Krugman says comparison invalid, due to WWII rationing and full employment. What is the response to Krugman argument?

"That seems to run completely counter to orthodox macroeconomic theory, winterspeak. When the government runs a deficit, it crowds out private investment; if the government takes a dollar in taxes and saves it, that's an extra dollar in national savings."

Nope. The Federal government can print money at will -- why does it need to tax in order to spend? In fact it does the opposite -- it spends in order to give us the money we need to pay our taxes (and do other stuff).

When a currency issuer spends, it creates money. When it taxes, it uncreates that money. It never needs to tax in order to spend. The difference between the money created (spent) and money uncreated (taxed) is our "Federal deficit". It is very different from personal debt, but then debt should be very different for a currency issuer than a currency user!

"If the government takes a dollar in taxes and gives it to someone else, that person will almost certainly not save the whole dollar."

Sure -- taxes reduce aggregate demand, as it leaves the taxed individual poorer. If the Government gives money to anyone else, some of that money will be saved, and some spent. My point is that the Government does not need to tax in order to spend.

"point of the stimulus (based on the arguments put forth in favor of it) is that we don't want people to save - we want people to be spending money."

The arguments put forward for the stimulus are, sadly, bogus.

We do want people to spend more money, but they aren't going to spend more until they've done some savings first. If the "stimulus" was a payroll tax holiday, people would save until they had paid down enough debt, and then start to spend again. At that point, you should see an increase in CPI and can declare the tax holiday over.

The result would be a larger Federal deficit (lower taxes mean a higher deficit, all else equal) and higher private savings. The money for the higher savings came from a higher Federal deficit, not lower private spending and investment (which is what is happening now).

"I think we need to transition away from a highly leveraged financial sector and instead have an economy where the nonfinancial sector finances expansion out of profits and by raising funds in straightforward ways from investors, without clever financial intermediation. The de-leveraging of the financial sector needs to be overseen in such a way that people do not lose access to basic banking services."

Greg,
Cut the employer contribution to the payroll tax in order to stimulate profits. Stop having Freddie Mac and Fannie Mae buy mortgages. Stop bailing out failed banks. No increase in government spending. More not-do's than do's, I guess

On more than one occasion, I have encountered the argument that the Depression was ended by WWII. When I point out that, sure we lowered unemployment by employing almost everyone in the war effort including sending millions overseas to kill and be killed, but that actual consumption by citizens was greatly constrained by the fact of this "stimulus out of depression, the reply is always the same- I am told that consumption was constrained because of enforced rationing. I am always flabbergasted by that response. That is what Krugman's response sounds like once again.

"I think we need to transition away from a highly leveraged financial sector and instead have an economy where the nonfinancial sector finances expansion out of profits and by raising funds in straightforward ways from investors, without clever financial intermediation....No increase in government spending."

Yes, yes, and yes. Or as they reputedly used to say during the so-called Reagan Revolution, "don't just stand there, undo something." I like to call this an "Equity Based Economy" (http://equitybasedeconomy.blogspot.com/). My thesis is that the impetus must originate in a general shift away from debt and towards savings and equity, but I agree completely that the Federal Government must cut spending and retreat to something resembling its Constitutional boundaries. That might explain why I voted for Ron Paul.

If the private sector is going to net deleverage, then we either need the public sector to leverage (higher deficit) or we need less transactions and investments. The money that people want to put in bank vaults must come from somewhere, and if it's not the Fed, then it's you and I.

On this blog, people don't want the Government to leverage up AND they want the private sector to leverage down, so I guess that means mass unemployment as we work our way back to the ten cent hamburger. (Chances of that = 0, btw)

Oh, and lower tax collection and higher unemployment benefits are increasing the deficit as we speak. The deficit will get larger, either the easy way, or the hard way. My vote is for the easy way.

A finanicial institution that sells one year bonds and uses the funds raised as well as its capital to buy 30 year bonds is involved in financial intermediation, providing liquidity, and is leveraged.

It is not creating money.

To say that the instutition should create less intermediation is to say that investors should hold fewer 1 year bonds and more of the 30 year bonds directly.

To say that there should be less leverage is to say that the institution should sell fewer one year bonds and issue more capital. That means that the investors should hold fewer one year bonds and more stock in the institution. They are indirectly holding the same amount of 30 year bonds.

To say that it should create less liquidity, would be to say that it should sell 5 year bonds rather than one year bonds. (No liquidity would involve holding 30 year bonds issued by the financial istitution which would be claims to other 30 year bonds.) That is to say that the investors should hold 5 year bonds rather than 1 year bonds.

Some financial institutions borrow with checkable deposits, saving deposits, and a variety of overnight borrowing. Some of this involves creating money.

This is important, but it isn't the same thing as leverage, liquidity, or intermediation.

But, always remember that while an individual financial institution can change its balance sheet without any perceptable impact on what the final investors are doing, when we talk about all of the financial institutions changing their balance sheets, we are not just talking about how they should finance their activities, but also, what kind of assets the investors shold own.

Less leverage for a single bank? I suppose we can imagine that as borrowing less. But for the whole system, it is financing more by equity and for the investors it is holding more stock and less CDs or commercial paper.

But maybe there "should" be less financing provided all together. That is, less stock and less bank liabilites should be held.

OK, but that means less investment and more consumption. Income earned from current resources to purchase consumer goods today produced with existing resources. There is nothing wrong with this, in my view, but that is the real alternative. Oh, of course, people can choose to stop working and enjoy more leisure.

WRT the private sector: my span of control begins with myself, where (as second in command of the household) I have some control over how much debt to assume; I am attempting to hold that to credit card debt payable at the end of the month. I have less control where I work - small business - where we constantly strive to keep a high ratio of direct to indirect employees and to avoid all but bridge loans (while awaiting collection on receivables). Beyond that, my influence on the private sector is reduced to decisions of whether or not to buy discretionary items. I admit to having turned cautious in that regard - when the bargains are so compelling that I am unable to resist, I will start buying again. If others do the same, I suspect that that will be the point when the recession begins to recede.

WRT the public sector: all government spending is a tax (current or future) on my earnings. For this and other reasons (freedom, efficiency, etc), I would like to see that spending reduced. Most people suffer during a recession, but IMO, the road to prosperity runs through the private sector and a sustainable ("equity-based") economy.

You're making a big assumption that this additional printing of money has no other cost. Given inflationary pressures, this penalizes all current savings and investments. You could argue that the cost imposed by this is overall less than the benefit from the direct government spending, but you can't say it isn't there.

MANIEL: You are correct -- you are a currency user and need to manage your money wisely.

You are incorrect in saying that all Government spending is a tax on you, now or in the future. The Government is a currency issuer, it can print money at will. The point of taxation is to uncreate some of that currency, and therefore, keep inflation down.

But we are in agreement that there are excellent reasons for wanting to see smaller G. Right now, I'd be happy with smaller G, but even smaller T, as the *deficit* at the Federal level has to increase.

But people on this board want the deficit to go down, which means we'll use unemployment to push it up to meet the private sector's demand for net savings.

RWard: All Government spending is with newly printed money, and I state this as a fact. Printing this money has no cost, as it is just changing entries in a spreadsheet -- this is a fact also.

But I never said that it has no consequences! Inflation is a very real (potential) consequence.

Right now we do not have inflationary pressures, we have deflationary pressures. This is why the deficit can increase without increasing CPI. By supplying the money for net private savings the easy way (higher G/lower T) we don't have to do it the hard way (higher unemployment automatically increases G and reduces T).

Doing this certainly penalizes savings, as cash in the bank becomes more valuable during deflation, but it probably helps investment as it supports aggregate demand.

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